Improving Access to Non-Bank Debt
CBI submission
February 2012
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The CBI is the UK's leading business organisation, speaking for some 240,000 businesses that
together employ around a third of the private sector workforce.
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Our contribution to the Taskforce builds on our extensive report into the challenges facing midsized firms in the UK (Future Champions, 2011), as well as evidence submitted to the Treasury for
the 2011 Budget.
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The CBI’s membership encompasses companies of all sizes and sectors, on both the supply and
demand side, so we believe we are well placed to contribute to the debate on access to finance,
including specifically improving access to non-bank debt.
The CBI welcomes the opportunity to feed into the review of non-bank lending. Through this
submission we make the case that:
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There are specific advantages to small and mid-sized firms, and to the economy, from
widening access to alternative sources of finance
Barriers to the supply of a more diverse range of lending options exist and can be addressed
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Barriers to the demand for alternative sources of debt finance must also be tackled
There are specific advantages to small and mid-sized firms, and to the UK economy as a whole,
from widening access to some of the alternative sources of finance that larger firms enjoy.
1. The principle opportunity offered by this review is to create a more sustainable business finance
landscape in the UK in order to lessen the impact of any future economic shocks on the ability of
smaller firms to borrow and continue to grow their business: diversifying sources of finance
beyond straight bank lending will help to leave a ‘spare tyre’ in the system in case of a banking
breakdown. Beyond cyclical issues, however, there is also currently a mis-alignment of financing
needs with the supply on offer: debt financing is often too short-term and small scale for firms
wanting to expand, and equity financing runs into issues around the size of injection required
Emma Wild | Head of Knowledge Economy & Markets
T: +44 (0)20 7395 8131 E: emma.wild@cbi.org.uk
CBI Centre Point 103 New Oxford Street London WC1A 1DU
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Director-General: John Cridland CBE President: Sir Roger Carr
Registered No: RC000139 (England and Wales) Registered Office: CBI Centre Point 103 New Oxford Street London WC1A 1DU
and the unwillingness of firms to relinquish control of their business. This review presents an
opportunity to positively reshape the UK’s lending landscape to better suit business’ needs.
2. Although this review is primarily focussed on the issue of debt finance rather than equity, this is
not always a distinction that smaller businesses use in their financial planning. In fact most
businesses distinguish more between their working capital needs, and their growth capital
needs, both of which could be met by either debt or equity finance. Some businesses lend
themselves more to equity capital, particularly technology companies (including internet
businesses) and hi-tech manufacturing firms, which require large initial investments before
generating revenue and seek investment based on intangible IP-based assets. On the other hand
many other businesses are only interested in debt finance, often because they are unwilling to
cede control of their company, or because releasing equity is not a part of their long-term
business strategy. Given that equity finance has recently been reviewed through the Rowlands
review we agree that there is a particular need to examine the state of debt finance for the UK’s
mid-sized and smaller firms, but we are very aware that problems with the supply of equity
finance in the UK remain and, as part of the broader growth agenda, we urge Government to
continue to look at all elements of finance for growing companies, including forms of equity
finance which are relatively under developed such as corporate venturing.
3. This paper does not seek to focus on the current economic situation and how best to overcome
the cyclical constraints arising from the credit crisis; instead, it focuses on the structural
elements of the UK lending landscape. However, in doing this there are clearly benefits to
finding solutions that ameliorate the effects of the economic cycle, and therefore help create a
more sustainable lending environment for businesses in the long run.
4. Bank lending provides a core and effective source of working capital for the vast majority of
firms, but for too long working capital from the banks has been the only source of finance that
many smaller firms use, and has thus been relied on to make investments for growth when other
forms of finance would have been more appropriate. Although equity finance can be a driver of
rapid growth for many firms, especially those who lack the tangible assets on which to secure
extensive debt finance, many smaller, often family-owned, firms in the UK are unwilling to
release the equity they have built up over many years; so improved access to long-term debt
finance could be a crucial development in helping to grow their business.
5. However, there is scope for significant improvement in the UK’s current lending landscape.
Business finance in other countries is more diverse: the UK has by far the smallest bond market
capitalization relative to GDP in the G7, and the most highly concentrated banking sector.1
Countries like Germany and the US have a bond market far more accessible to MSBs, and much
smaller firms are able to issue private placements in the US than in the UK. This gives MSBs that
want to grow, and have the capabilities to do so, the development capital they need to fund
their expansion.
Case study: Stuttgart Stock Exchange’s Bondm initiative
Like British MSBs, companies in the German Mittelstand have largely relied on bank loan facilities
to secure finance to support their growth ambitions. However, as in the UK, constraints on lending
post-financial crisis have turned attentions towards alternative sources of finance with new
funding options being developed to meet this demand.
1
Adam S. Posen, Getting Credit Flowing: A Non-Monetarist Approach to Quantitative Easing, 2009
2
One such option is the Bӧerse Stuttgart’s Bondm initiative, a corporate bond trading segment
targeted at Mittelstand companies and launched in May 2010. Companies can issue bonds directly
to a stable base of private investors in denominations of €1000 and in volumes that may go as low
as €25 million. They benefit from enhanced market profile as well as from a more diverse financing
mix. In preparing for the issue they are obliged to professionalise their governance structures and
processes, instilling disciplines that can prepare them for growth.
The initiative has proven extremely popular with both issuing companies and investors. By Autumn
2011 20 separate issues had been made by German companies, many of which have been
massively oversubscribed by investors buoyed by a highly liquid secondary market. The initiative
looks set to grow dramatically in years to come, as more companies become accustomed to issuing
their own debt – a recent survey[i] indicated that as many as one in four medium-sized companies
is planning to issue at some point in the future.
6. The legislative and regulatory response to the banking crisis – most notably the capital and
liquidity reforms - has undoubtedly put added pressure on bank lending as a source of
affordable business finance, especially for smaller firms. This, coupled with the potential for a
normalisation of prices following prolonged periods of relatively cheap debt, makes it all the
more crucial that the Government puts the issue of opening up alternative sources of funding to
businesses at the heart of its efforts to rebalance the economy.
7. If we can open up different forms of lending to small and mid-sized businesses, and help those
firms find the right forms of both working capital and growth capital it could be critical to the
UK’s economic health, helping to provide a more sustainable economic future for the UK’s
business community. The CBI’s recent report on MSBs, Future Champions, found that untapped
potential amongst the UK’s mid-sized firms could be worth £20bn to the economy by 2020, if
key barriers such as access to long-term finance are tackled. It is vital that all parts of industry
and Government work together to make this level of growth possible within the UK’s smaller
business community.
Barriers to the supply of a more diverse range of lending options exist and can be addressed
8. From discussions with both potential suppliers of alternative finance and the smaller business
community we believe that the main supply-side barriers to greater alternative lending relate to:
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the low visibility of alternative credit providers
the relatively high cost of carrying out due diligence on smaller companies
the lack of established market facilities to support greater investment in smaller firms
the lack of advice supplied to smaller businesses on alternatives credit options
Underpinning many of these factors is an issue of scale; the fact that it is far less economical for
firms who supply finance or advice to market their products to smaller companies than larger
firms, which ultimately means that lending at this level doesn’t happen. Solutions should both
recognise this as an overarching barrier and find ways to make it more attractive for firms to fill
this gap in the market.
9. Low visibility
Alternative providers of finance often do not have the opportunity to market their products to
smaller businesses. Such providers, struggle to compete with the historic presence of banking
branch networks throughout the UK on the high street. This not only limits the ‘shop window’
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choice on offer to businesses when looking for finance, it also reduces the overall pool of nonbank alternatives in the UK due to crowding out the non-bank talent and resources.
10. High costs of due diligence
Even if alternative providers of finance do manage to market themselves to smaller businesses,
there is no guarantee that these lenders can effectively assess the suitability of small and midsized firms for finance. Firstly, it is relatively more expensive for investors to assess the risk of
smaller firms than larger firms and secondly smaller firms are not always used to providing the
sort of financial information that investors need to judge risk. The result is that smaller firms are
often automatically given junk status, or in other words small firms are all seen as high risk for
potential investments. Whilst there are logical reasons that smaller firms often have a lower
credit rating than large ones – including the safety that comes with economies of scale – there
are clearly useful distinctions that could be made between types of SMEs and their credit
worthiness, which are currently missing from the credit scoring process. Unless alternative
providers put a lot of time and effort into their own due diligence processes, they are potentially
missing out on good investment prospects from smaller firms that are growing and have sound
business plans.
11. Lack of market facilities
Investors are also often reluctant to invest in SME or mid cap debt because important market
facilities are not in place; for example, brokers being willing to commit capital or develop
research. Since investors themselves do not have resources in place to undertake the levels of
due diligence needed to make investment in the larger number of small issues worthwhile, the
role of intermediaries is even more important, but the lack of activity in this area presents
another barriers to greater investment in smaller firms, and also makes it more difficult for an
active secondary market to emerge. Moreover, they are often unwilling to accept the additional
risks associated with the limited liquidity in the market. If there was an active secondary market
it could increase investment in smaller firms, as it would provide an early exit for investors that
didn’t want to tie their capital down for the entire length of the bond. Additionally, there may be
more investors willing to invest in the market if the regulatory rules were amended. For
example, there is currently a cap of 10% for insurers to invest in unsecured or unlisted
investments. Removing or at least increasing this cap could unlock future investment, providing
more liquidity in the market.
12. Lack of advice
There can also be a gap in the availability of advice about non-banking options. Accountancy
firms that often support small and medium-sized firms tend to be small themselves and are not
always geared to offer sophisticated advice on corporate finance and may not feel that there is
the demand for more sophisticated advice from smaller firms. The role of accountancy firms is
key in ensuring that businesses make the most suitable decision about the right type of finance
for their needs, yet without more comprehensive advice smaller firms simply don’t know what
the options are. Improving the advice on offer to businesses could be a key part of unlocking
greater alternative lending.
Recommendations for Government
Some of these barriers would be best tackled through some of our demand-side
recommendations (see later) eg the introduction of Independent Financial Business Advisers
could help tackle both the low visibility that alternative lenders have compared with banks, and
the lack of advice on offer.
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We believe Government could tackle the high costs of due diligence and the lack of market
facilities in the following ways:
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Stimulating investment in mid-cap debt. HM Treasury and the Department for Business
should ensure that the new Business Finance Partnership stimulates the market in mid-sized
bonds.
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Encouraging investment vehicles made up of mid cap corporate bonds. HM Treasury should
look at the feasibility of short term tax incentives, similar to the approach used for Venture
Capital Trusts, as a way of attracting investment in mid-sized bonds.
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Incentivising direct investment in bonds. HM Treasury should look at the feasibility of
supporting investors who wish to invest in small or mid cap firm debt by making coupons on
private placements and corporate bonds that meet certain criteria tax deductable or exempt.
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Broadening the base of investors. The Department of Business should look at ways to support
market led solutions to drive the growth of retail investment in corporate bonds, for example
through support of the London Stock Exchange’s Order book for Retail Bonds (“ORB”) and the
development of mid-cap bond indices.
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Introducing a new ISA for bonds. In the future, Government could also help generate retail
interest in the MSB bonds by setting up tax-free savings, to help ensure the longer-term
sustainability of the market. Tax-free savings via an ISA would help generate interest from
individual investors.
Barriers to the demand for alternative sources of debt finance must also be tackled
13. A number of other barriers are also acting against businesses desiring, actively seeking and
successfully obtaining alternative forms of debt finance. We have identified four specific barriers
to SMEs and MSBs accessing alternative sources of debt finance:
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Lack of awareness and education about the different sources of finance available
Lack of skills to successfully seek alternative sources of finance
Prohibitive perceived and real costs of obtaining alternative sources of finance
Lack of confidence in seeking alternative debt finance
Overcoming these barriers will require a concerted effort from both Government and industry to
help open up opportunities in alternative forms of funding to smaller businesses.
14. Lack of awareness
Survey data collected by the Department of Business and the CBI’s own research on MSBs
confirms that many smaller businesses do not have a high awareness of non-bank lending
options. For example only 20% of SMEs are aware of a local venture capital fund.2 Many SMEs
2
Department for Business ‘Financing UK SMEs survey’ (2007)
http://webarchive.nationalarchives.gov.uk/+/http:/www.bis.gov.uk/policies/enterprise-and-businesssupport/analytical-unit/research-and-evaluation/cross-cutting-research
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are not even aware of Government schemes in place to help them; for instance, only 22% of
SMEs are aware of the Enterprise Finance Guarantee (EFG) and only 8% are aware of the newer
EFG for Exporters. Indeed even with respect to traditional bank lending, only 20% of SMEs are
aware of the “Merlin agreements” despite the wide spread press coverage. This low level of
awareness necessarily leads to a situation where businesses do not get the opportunity to
consider the full range of finance options available.
15. As previously mentioned, one reason for this lack of awareness may be that the main
alternatives to traditional bank lending, if provided by non-banks, are not as visible to SMEs and
MSBs as mainstream banking products. The lack of alternatives being used by smaller firms may
also be reinforcing, as these firms rarely hear their peers discussing non-bank lending and so do
not consider it an option.
16. While the Government has introduced measures to increase financial awareness amongst small
businesses through the Finance Fitness campaign (launched November 2011) and the newly relaunched Access to Finance channel on businesslink.gov.uk (December 2011) it is too early to
gauge how many businesses they will reach and how successful such initiatives will be.
17. In order to complement the Government’s scheme, the CBI is committed to launching a series of
regional clubs to enable MSBs to benefit from peer-to-peer learning and to access advice from
relevant experts. One of the main themes covered will be access to long-term finance, with the
aim of exploring whether and how MSBs access alternatives to traditional forms of bank lending
to grow their business.
18. Lack of financial expertise
Both lenders and smaller businesses themselves acknowledge that SMEs and some mid-sized
firms often lack the financial expertise required successfully to obtain the right finance for their
business. This poses two significant problems: firstly, they are unable to find alternatives to
traditional lending and analyse the options available; secondly, they sometimes struggle to
present themselves as a viable lending proposition through full and detailed business plans.
19. We believe this lies in the fact that few SMEs have sufficient financial expertise within their inhouse management team. For instance, only one in five (22%) of those responsible for making
finance decisions in SMEs had a financial qualification or financial training, although only a
quarter of businesses at the larger end of the SME scale, with 50-249 employees, do not have a
qualified finance manager.3 Moreover, of SME employers that apply for finance, 41% do not
understand the way banks assess credit risk, which will make it difficult for SMEs to put robust
finance proposals forward.4 That many small firms appear to lack a dedicated finance director
and treasurer – with the owner-manager or MD often taking on the financial management of the
company – is a major barrier to getting SMEs to understand that non-bank sources of finance are
serious alternatives to traditional lending.
20. A lack of financial expertise can also limit the willingness of businesses to seek advice from third
parties, especially as some SMEs and MSBs tend to emphasise the cost of external advice rather
than the value it brings. Most SMEs do not seek advice when applying for finance: only 9% of
SMEs sought advice when seeking an overdraft and 19% of SMEs seeking a bank loan sought
3
SME Finance Monitor Q3 2011: Developing a deeper understanding
4
BIS Small Business Survey 2010
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advice5. There is the potential for non-executive directors to be a useful source of financial
advice for SMEs and MSBs if the director has prior experience of using alternative sources of
finance, yet smaller firms have a mixed experience of using NEDs for a number of reasons – not
finding the right people, not knowing where to look for NEDs, in some cases being reluctant to
welcome new ideas from outside the organisation. In practice it is very difficult to match the
right talent as many non-executives with a wide financial experience are likely to have a
background in larger public companies, which doesn’t always make them the best fit for smaller
privately owned firms.
21. Prohibitive costs
The lack of financial expertise and awareness about non-bank finance is compounded by both
the perceived and real cost of obtaining alternative sources of finance. Alternative sources of
working capital such as factoring and invoice discounting are perceived to be much more costly
than traditional lending, and are therefore used by many only as a last resort, to keep their
business afloat. Unless done confidentially, such products also then have negative association
i.e. businesses that use invoice discounting are automatically assumed to be in decline.
22. For longer-term capital lending cost can also be a barrier. One of the main reasons that even
quite large MSBs don’t issue debt on the public markets, or via private placements is the high
costs involved. Costs for issuing debt lie in the need to collect and present financial information
to potential investors in a prospectus, and the legal fees needed to complete complex
documentation. The costs of obtaining a credit rating are also fairly fixed, so can be prohibitively
expensive for smaller firms to obtain. Whilst some of these costs are necessary, there are small
steps that Government could take to lower the bar slightly in cost terms and increase the
incentives for businesses to look into alternative arrangements.
23. For all types of alternative debt finance SMEs and MSBs may have the perception that non-bank
lending is more expensive. This may only be a perceived higher cost because businesses are
unable accurately to compare the true costs of all the options available to them over the long
term. Clearly some types of alternative finance such as private placements, where the covenants
are often more rigid and restrictive than would be typical for bilateral bank loans, can seem
expensive, but the true cost of a bank loan may be disguised by the fact that the business is also
taking out other financial products with the bank, or that the upfront cost doesn’t include
refinancing costs that will be incurred over many years. The effect of this lack of information is
that, though unhappy that bank costs are increasing, many firms simply take a ‘better the devil
you know’ approach to their finance.
24. Low confidence
The final major barrier to greater demand for alternative sources of finance we identified is
confidence. There is evidence to suggest a combination of a lack of confidence in their own
abilities, the current trust deficit with traditional lenders, and a lack of confidence in the
economy generally, is acting as a barrier to many SMEs raising alternative forms of finance. For
example, more SME employers perceive they are poor in their own ability to access finance
(38%) than perceive they are strong in accessing finance (25%). This sense of their own
weakness in this area, allied with the ‘mood music’ around banks, is likely to be having a
discouraging impact on demand for all forms of finance.
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SME Finance Monitor Q3 2011: Developing a deeper understanding
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25. Firms clearly lack confidence and trust in banks as a result of the financial crisis, which
underlines the importance of opening up other forms of finance, both now and for the future (to
try and ensure a more sustainable business finance landscape during future cycles). Yet the
financial crisis has made smaller firms risk averse in many aspects, which means that many are
trying to reduce their overall reliance on debt, by retaining internal cash reserves, and also
means that they are unlikely to try forms of debt finance that they are unfamiliar with. Such
forms of finance are all too easily classed as too difficult and too costly. In this context, the result
is that firms are more likely to stay with their bank than change to an alternative lender, perhaps
reticently displaying the ‘better the devil you know’ attitude.
Recommendations:
We believe the Government can help tackle barriers to greater demand for non-bank lending in
the following ways:
Lack of awareness and low confidence:
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Facilitating the introduction of Independent Financial Business Advisors. The Government
should explore ways to expand the successful programme of Independent Financial Advisors
(IFAs) that consumers have benefited from, tailoring it to the needs to SMEs and MSBs. These
advisors could help to fill the in-house gap in financial expertise, providing information on
different sources of available finance, and helping businesses work out which form suits their
needs best.
Ensuring IFBAs are accessible to SMEs and MSBs. The Government should also consider how
best to maximise access to these advisors. Bank branch networks provide an extensive reach
into all regions, and are thus well suited to the purpose, and Government could incentivise
banks to house IFBAs by allowing debt placed with third parties through IFBAs to be included
in the calculation of any industry targets. Another option for the positioning of IFBAs could
include building on the already exceptional advice and guidance offered in the large network
of the Citizens Advice Bureau.
Lack of financial expertise and prohibitive costs:
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Working with industry to achieve greater standardisation in documentation for non-bank
finance. Much of the off-putting cost and complexity of non-bank finance such as bonds and
private placements comes from the complex documentation that firms need to compile,
incurring accountancy and legal fees in the process, as well as taking up valuable staff time. If
this process could be standardised it could reduce the cost and administrative burden of such
forms of finance and make alternatives much more attractive to smaller firms.
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Educating firms about the possibilities of bond issuance. The Government should support
industry-led educational efforts targeted at mid-caps, including advice provided by banks.
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